Gupta Insider Trading Case: Define 'Material' and 'Nonpublic'

Stocks move lower midday; primary cause is likely a spike in oil to just below $100.

Elsewhere, SEC charges again revives interest in what exactly constitutes insider trading, and why the key phrase is "material" and "nonpublic."

The SEC is alleging that a former board member of Goldman Sachs and a current member of the board of Procter & Gamble , Rajat K. Gupta, has provided information to Raj Rajaratnam of Galleon that amounts to insider trading.

The origin of insider trading laws go back to the Securities Exchange Act of 1933. Section 10 makes it unlawful:

"To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, or any securities-based swap agreement (as defined in section 206B of the Gramm-Leach-Bliley Act), any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors."

The key phrase is it is unlawful to use "any manipulative or deceptive device" to purchase or sell securities.

Separate rules enacted pursuant to this provision made unlawful "the purchase or sale of a security by one who is in possession of material information relating to [a] tender offer which information he knows or has reason to know is nonpublic and which he knows or has reason to know has been acquired directly or indirectly."

Here is the two important requirements: they must have "material information" and it must be "nonpublic." This is the classic definition of insider trading used by the courts.

The Sarbanes Oxley Act also made it criminal to defaud any person in connection with securities, or falsely or fraudulently obtain money or property in connection with the sale or purchase of any security.

Misappropriation. The Supreme Court significantly expanded the concept of insider trading in United States v. O'Hagan in 1997. Here the Court created a "misappropriation theory" that held that a person commits a crime when he "misappropriates" confidential information for the purpose of trading securities. Mr. Gupta was an investor in "at least some of the Galleon funds" according to the SEC complaint. It implies that if there is a duty owed to the source of the information, a crime may have been committed.